Editor's note: The First Circuit later vacated the
decision in the Textron decision discussed here,
reheard the case en banc, and reversed the district
court. See Textron Inc., No. 07-2631 (1st Cir.
8/13/09).

Textron
is a publicly traded conglomerate with approximately 190
subsidiaries. Like other large corporations, Textron’s federal
tax returns are audited periodically. Textron and its
subsidiaries annually prepare tax accrual workpapers.

Textron’s
tax accrual workpapers were prepared by attorneys and CPAs
working for Textron. Textron’s subsidiary companies prepared
their workpapers with some input from private law firms and
outside accounting firms. According to Textron officials,
Textron’s ultimate purpose in preparing the tax accrual
workpapers was to ensure that Textron was “adequately reserved
with respect to any potential disputes or litigation that
would happen in the future.”

During
an audit of Textron’s 1998–2001 tax years, the IRS issued more
than 500 information document requests to Textron. Textron
refused to comply with any requests that sought tax accrual
workpapers, asserting that the workpapers were protected by
attorney-client, tax practitioner–client, and work-product
privileges.

The
district court, after considering whether the privileges
applied and whether Textron had waived the privileges, held
that work-product privilege applied and had not been waived
(the others had been waived), so Textron did not have to give
its tax accrual workpapers to the IRS.

The
work-product privilege (or work-product doctrine) is related
to the attorney-client privilege and applies to materials
prepared or gathered by an attorney in anticipation of
litigation (Fed. R. Civ. Pro. 26(b)(3)). Under this privilege,
a party seeking an attorney’s work product covered by the
privilege is entitled to it only on a showing of a substantial
need for it.

The IRS
had argued that because Textron was required by financial
reporting rules to create the requested documents, the
privilege could not apply. But the First Circuit stated that
“the presence of a business purpose does not defeat
work-product protection” (Textron, slip op. at
12).

The
court also held that the resolution of audit disputes with the
IRS meets the definition of litigation. The court found that
the “driving force” behind the preparation of the documents
was the need to reserve money in anticipation of disputes with
the IRS (i.e., litigation). Therefore, the work-product
privilege applied to the workpapers.

The
district court had held that Textron had not waived the
work-product privilege by showing the workpapers to its
auditor. The First Circuit remanded the case to the district
court for reassessment of the question of whether the
privilege had been waived.

For more
on the district court’s decision, see Tax Trends, “District
Court Holds That Tax Accrual Workpapers Are Privileged
Documents,” 38 The Tax Adviser 756 (December
2007).

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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